If you read our recent post entitled “How To Build Equity in You – Part 1“, and developed a plan to pay down your consumer debt using the power-payment method, you might be thinking, “OK, I’m paying down my debt. Now what?” Well first, congratulations! You’ve taken an important step toward financial independence. But there’s another element to becoming truly solvent. That’s creating an emergency cash reserve. For the purposes of this discussion, we’ll define emergency cash reserve as:
enough cash on hand to cover minimum living expenses for at least 6 months.
Here’s why: If, for some unforeseen reason, you lose the income you’re living on and paying your bills with; it’s critical that you have enough cash on hand to continue having food to eat, a roof over your head, and making minimum payments on your various outstanding obligations (aka. debts). Otherwise, you’ll end up going back even farther than square one.
Of course, you probably can’t just wave a magic wand and have 6 months worth of cash suddenly appear. And you certainly wouldn’t want to use a credit card to pay for food, etc. So, how do you create an emergency reserve? Simple – You save it. here’s how:
1. Determine How Much You Need
You should already have some sort of income and expense sheet. The expense part can tell you at a glance what your monthly expenses are. If you don’t have one, create one. Your monthly expenses will probably consist of the following:
Housing expenses (including utilities)
Personal expenses (groceries, personal items)
Total these, and any other monthly expenses not listed here, multiply by 6, and you’ve got the target number for your emergency reserve.
2. Open a Special Savings Account
Regardless of how many savings or checking accounts you have, a separate savings (not checking) account used exclusively for your emergency reserve is a must. Otherwise, it’s too easy to dip into the emergency reserve “just this once” to cover some pseudo-emergency like dinner at your favorite expensive restaurant. Simply put, it’s easier to maintain discipline of you create a separate savings account and keep the passbook out of sight somewhere.
3. Start Accumulating Funds
You’ve probably heard that saying about how to eat an elephant, right? well, creating an emergency reserve is exactly the same. And the best way to start is just to start – with whatever amount you can. Then commit to putting a certain amount from each paycheck into your emergency reserve account. You’ll be amazed at how quickly that fund will grow.
Most people seldom, of ever, think about what they would do if they lost their job or were otherwise unable to meet their monthly obligations – until such an emergency strikes. By starting now building your emergency reserve, you’ll be improving your personal equity position.